China trip report
Comment of the Day

September 25 2012

Commentary by Eoin Treacy

China trip report

Eoin Treacy's view In Comment of the Day on September 6 th I posted an article discussing McDonalds intentions to open vegetarian restaurants in India. This exemplifies a wider trend among restaurant chains in attempting to tailor their offering to national palates. Yum Brands has been perhaps the most successful in following this strategy with its Chinese revenue overtaking that of the USA in 2010.

Starbucks announced last week that it is in the process of adapting its menu to offer more choices that appeal to local Chinese tastes. Part of the same story also pointed out that its Chinese operations have a 35% margin compared to an average of 22% for the USA. Against that background it is easy to understand why Starbucks is taking care to foster the Chinese market. The share hit an accelerated peak in April and pulled back sharply. It found at least short-term support near $43 and has held a progression of higher reaction lows since. A sustained move below $49 would be required to question medium-term scope for some additional upside.

On one of the connection flights I took to get to Shenzhen, all the people sitting around me were representatives of furniture companies, (mostly leather and PVC sofas), on their way home from an international trade fair in Shanghai. While the atmosphere was convivial no one was happy with business. The US and European buyers they had hoped to find did not turn up and this is the fourth year where new orders have declined. We heard similar accounts of the Shenzhen Jewellery Fair where a number of the factories Mrs Treacy visited had stalls. Everyone remarked on how quiet it had been and were hoping for a better experience in Hong Kong this week. These experiences gel with what I heard from other areas of China on my last trip in February.

On the commuter train from Guangzhou to Shenzhen I chatted with an American who is helping manage a factory in Shenzhen. His company is finding it challenging to keep up with their order flow. He related how it was really only the large factories which have moved inland to avail of lower labour costs, for example Foxconn. Scale is required to justify the move and even then they maintain a presence in Guangdong to collect orders. He also mentioned how his company is under constant pressure to increase the sophistication of its operations. He said this limits the number of jobs that can be moved to more rural areas because of the expertise that has been developed in Guangdong over the last few decades. The only factory Mrs. Treacy visited that was truly busy was one offering rapid prototyping, 3-D computer aided design (CAD) images and focused more on small highly detailed runs than mass production. Their “moulding” also cost three times more than any other factory she visited.

These two experiences suggest that while the traditional model which relied primarily on low labour costs had been forced to adapt, companies that have successfully moved up the value chain are faring substantially better. There is every reason to expect this trend to continue.

While I was talking to the American chap, Mrs Treacy was seated opposite an envoy for the Shenzhen development authority who had just returned from a meeting with an Indonesian business person who is building a chain of hotels but came to China to source the customised furniture to outfit them. While a minor example, this also helps to emphasise the increased role of intra emerging market trade, particularly as the USA and Eurozone remain low growth environments.

While in Shenzhen two protests against Japan's purchase of the Diaoyu/Senkaku islands ensured that our taxis had to take rather circuitous routes. We also heard that Japanese restaurants had experienced a significant decline in business as a result of the affair and travel plans to Japan were cancelled by a number of politically connected corporations. The fact that China's decennial leadership change is approaching and that Japan's leadership is under pressure probably contributed to this issue taking greater significance than it might otherwise have. One can hope that calmer heads prevail over the coming weeks. The longer-term problem is that anti-Japanese sentiment is never far from the surface and has long been an easy target for those seeking to divert attention from internal concerns. It suggests that relations are likely to remain strained for quite some time.

Despite the fact that its July earnings announcement was well ahead of estimates and it has significant business interests in Asia Pacific, where weight loss is an increasingly lucrative market, Herbalife has so far failed to recover from Jeremy Einhorn's inquisition earlier this year. The share has now encountered resistance in the region of the 200-day MA on successive occasions and a clear upward dynamic will be required to check downward momentum. Nu Skin Enterprises moved to a new reaction low last week and will need to break the progression of lower rally highs to begin to offset potential for additional weakness.

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